Royal Ahold: An analysis
ROYAL AHOLD:1. Introduction
Headquartered in the Netherlands, Royal Ahold is one of the world’s largest international retail grocery and food service companies. At its peak in 2001, Ahold’s reported sales and profits were ˆ66.6 billion and ˆ1.1 billion and it operated 5,155 stores in 27 countries with nearly a quarter of a million employees. Ahold was started as a family firm in 1887 by the Heijn family. It was a family-controlled business, operating primarily in the Netherlands for over 100 years. The company went public in 1948. In 1989, Ahold underwent a major transition from a family-controlled to a management controlled firm. This transition resulted in a phenomenal period of success for the firm. It generated over a 1,000% return for its shareholders and had a market capitalization of ˆ30.6 billion by November 2001.
In February 2003, Ahold witnessed a reversal of fortunes and suffered a complete meltdown. The firm was in a complete disastrous state with nothing going in their favour: a failed strategy, an accounting scandal, the firing of professional management, and litigation filings from all parts of the world. Shareholders lost most of their returns generated since 1989. Ahold scandal gave Europe a reason to believe that corporate governance and accounting problems were not restricted U.S. only. Ahold became “Europe’s Enron” (The Economist, March 1, 2003). It caused Dutch and European policymakers to rethink their approach to corporate governance and accounting policy. The Royal Ahold scandal, along with the accounting fraud at the giant Italian firm Parmalat, caused the European Union (EU) to impose more extensive and rigorous regulation on the financial reporting system and independent audit function within its member nations. The Royal Ahold debacle also reignited the debate regarding the need for more uniform accounting and auditing standards around the globe.
In the Netherlands, a committee on corporate governance was installed on March 10, 2003 (Tabaksblat Committee, 2003) to restore the lost confidence in public companies.
This report aims at studying the inter-relationships between the lack of corporate governance and of accounting transparency which led to the downfall of Ahold. The subsequent policies and strategies of the firm which aimed at reviving the firm are also aptly covered in the report.
2. The Growth Story: Expanding Boundaries
Over the years, Ahold evolved from a single grocery store in 1887 to a food company with a dominant position in the Netherlands. By the mid-1970s, Royal Ahold’s management realized that for the company to continue to grow it could not limit its operations to The Netherlands. Since the Netherland market was already dominated by Royal Ahold, the company’s top executives, who had long been known for their conservative operating and financial policies, announced their plan to expand its operations into other countries.
Royal Ahold’s expansion efforts got off to a slow start but then accelerated rapidly in the 1990s after the company hired a new management team. Until the late 1980s, members of the Heijn family had occupied the key management positions within the firm. In 1987, two grandsons of Albert Heijn, served as Royal Ahold’s two top executives. Later in 1987 when the brothers retired, a professional management team was hired to replace the Heijn brothers. The team recognized that the quickest way for Royal Ahold to gain significant market share in the grocery retailing industry outside of The Netherlands was to purchase existing grocery chains in foreign countries. To finance their growth-by-acquisition policy, Royal Ahold’s new executives raised large amounts of debt and equity capital during the 1990s. By 2000, Royal Ahold had purchased retail grocery chains in Asia, Eastern Europe, Latin America, Portugal, Scandinavia, South America, and the United States. This aggressive expansion campaign made Royal Ahold the third largest grocery retailer worldwide by the turn of the century. At the time, only U.S.-based Wal-Mart and the French firm Carrefour SA had larger annual retail grocery sales than Royal Ahold. Royal Ahold completed its most ambitious acquisition in 2000 when it purchased U.S. Foodservice, a large food wholesaler headquartered in Columbia, Maryland, a suburb of Washington, D.C. Although Royal Ahold had previously purchased several retail grocery chains along the eastern seaboard of the United States, including New England-based Stop & Shop, U.S. Foodservice was easily the largest U.S. company it had acquired. The U.S. Foodservice acquisition was also important because it signalled the company’s commitment to becoming a significant participant in the food wholesaling industry.
In 2003, after purchasing two smaller U.S.-based food distributors, Royal Ahold ranked as the second largest food wholesaler in the United States—Houston-based Sysco Corporation was the largest. In fact, the three U.S. acquisitions caused food wholesaling to be the company’s largest source of revenue, accounting for slightly more than one-half of its annual sales. The company’s more than 4,000 retail grocery stores located in 27countries accounted for the remainder of its annual sales.
3. Problems Due to Expansion
The aggressive growth strategy adopted by the new professional management gave rise to a number of unexpected and unanticipated problems. Among these the major problems were caused primarily due to the expansion in the global regions. The differences in the cultural norms hampered the ability of the management to manage its worldwide retail grocery operations.
As the firm ventured into new markets, especially the markets outside of Western Europe and the United States, it faced new challenges in the face of wide range of laws, regulations and cultural differences. The management team also faced difficulty in dealing with human resource policies regarding hiring, appraisal, and other employee benefits. The policies which were successful in The Netherlands failed to live up to the expectations of the new managers and employees in the countries of Asia, Latin America and South America.
Furthermore the cultural norms of grocery shopping among the consumers in global markets also exacerbated the misery of the firm. Some consumers out rightly rejected the “Dutch: idea and way of organizing the grocery store. The consumers also did not appreciate the idea of “foreign invader” replacing the local grocery stores which existed there for years.
4. Response towards the Problems and Further Issues
Since the problems were primarily the result of cultural and social issues, the management at Ahold decided upon the strategy of using the management personal of the local grocery chains and retaining them when those chains were acquired by Ahold. The new mangers were empowered with the authority to make major decisions.
The Royal Ahold ambitious plan to become a major player in the wholesaling segment of the huge food industry in the US gave rise to new problems. Most of the company officials were unfamiliar with that segment. Therefore they adopted the “hands-off” mindset to the acquisition and depended primarily on the executives of U.S. Foodservice who were retained following the buyout to oversee the subsidiary’s day-to-day operations. But the firm adopted a policy of following the same rigorous performance standards that were imposed on the company’s domestic operations. The company’s established goal of 15% annual growth rate in profits was used to decide upon the annual sales targets for each of the company’s operating unit in Netherland and also at global locations.
The units were pressurised to achieve their target and there were significant rewards on meeting the specified targets. But due to increased competition and the relatively lower profit margins within the food industry prevented many of those units from achieving the annual earnings goals that had been assigned to them.
5. Accounting Issues
During the fiscal 2002 audit of Royal Ahold, Deloitte Accountants uncovered evidence suggesting that the company’s consolidated revenues had been inflated and overstated.
When Royal Ahold invested in a foreign company, it often acquired exactly a 50 percent ownership interest in the given company. Nevertheless, Royal Ahold would fully consolidate the company’s financial data in its annual financial statements.Dutch accounting rules at the time permitted a parent company to fully consolidate the financial data of a joint venture company if the parent could control that firm’s operations. Such control could be evidenced by a more than 50 percent ownership interest in the joint venture company or by other means.
Royal Ahold persuaded their Deloitte auditors by providing them with “control letters” officially signed by the officials of joint venture companies. This was accomplished by taking the officials to their side by bribing them. Further in order to placate the company’s executives, the Royal Ahold’s management team signed “side letters” addressed to the company’s executives of the JV. These letters affirmed that the decision making was mutual rather than by Ahold exclusively. Thus for Dutch accounting purposes, the joint ventures’ operating results should have been “proportionately consolidated” in Ahold’s annual financial statements.
Apart from such improper accounting, Royal Ahold was also accused of not sharing the full information among the stakeholders. It did not reveal its obligations to purchase the ownership interests of certain investors in those companies. This was because of the default on the part of the joint venture companies to pay off their outstanding debt.
Fraudulent Accounting at U.S. Foodservice
Deloitte Accountants’ U.S. affiliate, Deloitte & Touche, audited the financial statements of U.S. Foodservice after that company was acquired by Royal Ahold in 2000. Before the acquisition, KPMG was its auditor. Deloitte uncovered anomaly in the account books which distorted the consolidated net income of Ahold group. Subsequent investigation revealed that US food Service had misrepresented their financial statements for several years before the acquisition.
The misrepresentation was because of improper accounting of the “promotional allowances.”
Since the food wholesaling industry is intensely competitive, so the profit margins on their sales are relatively small. This led to the concept of “promotional allowances” (refund on purchases) being paid to food wholesalers by their suppliers or vendors.
Another common practice or rather malpractice was “front-loading” promotional allowances.
This means accounting for all the allowances prior to its actual period.
The absence of proper internal controls over promotional allowances provided an opportunity for dishonest employees to overstate those allowances for accounting purposes.
6. The Aftermath
In 2003 when the company issued the restated financial statements for the preceding there years, the fraud was uncovered. The net income figures for the years 2000, 2001 and 2003 had been overstated by 17.6%, 32.6% and 88.1% respectively. The corresponding figures for the reported revenues were 20.8%, 18.6% and 13.8%.
Soon after the disclosures were made the regulatory agencies, law authorities, investment companies and other stakeholders began seeking more information regarding the fraud. Following the public disclosure both Dutch and U.S. law enforcement authorities filed criminal charges against the company and several of its former executives. Upon investigation, the responsibilities for the fraud lay on the top executives of the firm. The so called “professional management” which replaced the Heijn-family management in the 1990s were the forces responsible for the crisis. They over estimated their growing potential and set unrealistic targets at the company level. These targets where passed on to the individual units which were pressurised to achieve these unrealistic targets by hook or by crook. This was further enhanced by a significant level of rewards attached to the meeting of targets.
Role of the Auditor
Though it was because of the Ahold’s auditor Deloitte that the crisis was finally ended, but it cane under severe criticism for letting this fraud flourish to the extent it had reached. There were many lawsuits filed against Deloitte for the shear reason of negligence on their part which required them to prove their integrity. The loosely organized operating units under Ahold group made the auditing task a tough one.
Regulatory Bodies
The following controversy also revolved around the inefficiency and loopholes of the present in the regulatory system. The Ahold case re-affirmed the need for cooperation among the different regulatory bodies across countries. This was evident in the wake of rapid globalization which had taken place in the 1990s. Also the need for a common framework of regulations was further enhanced to maintain the comparability aspect of the account books across globe.
7. The Verdict
The fraud charges against the Royal Ahold corporate house were finally settled in September 2004. The verdict required the firm to pay a fine of 8 million Euros. Further after investigation the Royal Ahold’s former executives (CFO and CEO) were found guilty and were penalized as well as were sentenced to four to nine months of imprisonment
8. The Road to Recovery program
Press release is issued by Royal Ahold N.V
“Our highest priority now is to rebuild the value of our company. We will do everything in our power to create a company of which you can once again be proud….
Reinforcing accountability, controls and corporate governance…
Ahold is replacing a decentralized system of internal controls that had many weaknesses with a one-company system with central reporting lines. Internal audit will not only report to the CEO, but also to the Audit Committee of the Supervisory Board. In addition, Ahold has nominated Peter Wakkie to the position of Chief Corporate Governance Counsel on the Executive Board, to serve as the driving force behind improved internal governance policies and practices, for legal compliance as well as conformance to ethical and social standards…. ”
